DOI: 10.5176/2010-4804_2.4.270
Authors: William Coffie and Osita Chukwulobelu
Abstract:
Risk is often expressed as cost of capital in the context of investment valuations. The estimation of an appropriate discount rate to evaluate investment cash flows in order to determine its viability is the most important in the capital budgeting process, whether it is a multinational or small size company. From a strategic point of view, determining the appropriate cost of equity capital is critical in reducing the uncertainty that multinationals (MNCs) and domestic companies face when investing in different countries. Differences in risk and a lack of understanding of how emerging African stock market returns are influenced by the developed markets, as well as lack of reliable long-standing historical market data, are factors that international investors and corporate managers have to cope with. Most companies estimate their cost of equity capital using the Capital Asset Pricing Model (CAPM). However, the use of CAPM to estimate cost of equity capital in emerging African capital markets has numerous challenges, which are discussed in the literature below. This study is designed to empirically investigate whether the CAPM is a sufficient asset pricing model to estimate cost of equity capital in Kenya. A time series methodology was followed and the result showed that although the CAPM’s beta significantly explains equity returns, there are other risk factors not captured by CAPM. This means corporate managers and investors must beware.
Keywords: Beta, Capital Asset Pricing Model, Cost of Equity Capital, Emerging Market
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